Adds new comment, adds U.S. rate futures, updates yields

By Gertrude Chavez-Dreyfuss

NEW YORK, July 10 (Reuters) - U.S. Treasuries slid on Friday as investors focused on renewed tensions between the United States and Iran, while disruptions to traffic through the Strait of Hormuz fueled concerns that rising oil prices could add to inflationary pressures.

U.S. President Donald Trump said on Friday Iran had asked to continue talks and the U.S. had agreed, but noted that the June ceasefire was "over."

U.S. crude futures fell 1.3% to $71.09 for CLc1, but remained on track for weekly gains of 3.5% in the wake of the attacks.

Overall daily tanker traffic in the Hormuz strait slowed, data showed, as the conflict flared up. Prior to this week's attacks, daily tanker traffic had risen to its highest since the war began, averaging 40 ships transiting the strait.

"The key concern for the rates market is actually the drivers that ultimately will keep inflation from returning back to the Fed's 2% target. And among those is ... the energy shock," said Dhiraj Narula, U.S. rates strategist at HSBC in New York.

In afternoon trading, the benchmark 10-year yield rose 3 basis points (bps) to 4.569% US10YT=RR, after hitting a seven-week high on Wednesday. U.S. 30-year bond yields were up 1.8 bps at 5.071% US30YT=RR after also climbing to a seven-week peak on Wednesday. Rising yields mean bond prices are lower.

On the shorter end of the curve, the yield on 2-year notes US2YT=RR, the maturity most sensitive to expectations for Federal Reserve rate moves, advanced 5 bps to 4.212%. On Wednesday, the 2-year yield touched its highest in two weeks.

Treasury yields overall rose for a second straight week. U.S. 10-year yields, for instance, rose nearly 20 bps in the last two weeks, their best gain that period since mid-May.

The two-year yield also climbed, advancing more than 12 bps in two weeks, the largest rise since the week of May 18.

U.S. Treasuries also came under modest pressure after Japanese Finance Minister Satsuki Katayama said the government was pursuing measures that would encourage the Government Pension Investment Fund, the world's largest pension fund, to make "substantially greater investments in Japanese financial assets."

Japan is the largest non-U.S. holder of Treasuries with holdings of about $1.2 trillion, raising the prospect that greater home-market allocations could temper demand for U.S. government debt.

"The landscape for buyers is one that probably is a matter of timing," said Tom Nakamura, head of fixed income and currencies at AGF Investments, in Toronto.

"If as a result of ... a more clear announcement or a firm directive, we see U.S. Treasuries sell off ... at a certain point (yields) become attractive where investors may step in to fill some of the demand."

OVERSOLD CONDITIONS IN US RATES

Still, some analysts argued that the recent selloff may have run its course. Ian Lyngen, head of U.S. rates strategy at BMO Capital wrote in a research note that the rates market remained oversold and could be poised for a reversal. He cited a "bullish cross" on technical charts that would imply renewed buying interest in Treasuries.

"While there remains a reasonable amount of headline risk from the Middle East over the weekend, we remain constructive on duration as the market pulls back from this week's bearish extremes," Lyngen wrote.

In other parts of the bond market, the yield curve flattened on Friday with the gap between 2-year and 10-year yields narrowing to 35.3 bps US2US10=TWEB, compared with 37.2 bps late on Thursday.

The curve showed a bear flattening scenario, in which short-term interest rates are rising more sharply than longer-dated maturities, suggesting expectations of an imminent interest rate hike from the Fed.

U.S. rate futures on Friday priced in a moderately higher chance of a rate increase of 31.5% at this month's Fed policy meeting, up from about 24.6% on Thursday, according to the CME's FedWatch.

HSBC's Narula, however, took exception to the rate hike view, saying he believes the Fed will remain on hold this year and next -- neither hiking nor cutting.

"There's no hike because we do think some of these upward accelerating pressures on inflation like oil prices will eventually fade away," he said.

Narula doesn't believe the Fed will cut either.

"Growth is robust and labor markets are holding strong, but the underlying trajectory -- that last mile of sticky inflation -- hasn't showed enough evidence of going away. Net, net, that means no cut."